This credit analyst case study asks you to evaluate a hypothetical USD 300,000 business loan. Your decision should focus on three questions: Can the borrower generate enough cash for its debt payments? Is total debt reasonable relative to earnings? Does the company have enough liquidity to manage short-term obligations? Review the application, calculate the ratios, identify missing evidence, and then compare your conclusion with the corrected credit memo.
Credit analyst case study: the loan application
The applicant is Harbor Office Supply LLC, a hypothetical U.S. wholesaler that sells office products to regional businesses. Management is requesting a five-year USD 300,000 term loan. It plans to spend USD 250,000 on warehouse equipment and retain USD 50,000 as additional working capital.
Assume an illustrative fixed annual interest rate of 8% with equal annual payments. This simplified structure makes the exercise easier to calculate; an actual commercial loan may require monthly payments, fees, collateral documentation, financial covenants, or a personal guarantee.
| Application item | Hypothetical information |
|---|---|
| Loan request | USD 300,000 |
| Purpose | USD 250,000 equipment; USD 50,000 working capital |
| Term and assumed rate | Five years; 8% fixed annual rate |
| Annual revenue | USD 3,000,000 |
| Earnings before interest, taxes, depreciation, and amortization (EBITDA) | USD 300,000 |
| Existing debt | USD 500,000 |
| Existing annual debt service | USD 110,000 |
| Cash available for debt service | USD 220,000, based on the assumptions below |
All company figures are invented for this exercise. They aren’t observed results from a real borrower. Treat management’s numbers as unverified application data rather than established facts.
Review the borrower’s financial statements
Harbor reports USD 3,000,000 of revenue and USD 2,100,000 of cost of goods sold, producing gross profit of USD 900,000. Cash operating expenses are USD 600,000, leaving EBITDA of USD 300,000. Depreciation is USD 80,000, interest expense is USD 45,000, and reported tax expense is USD 44,000, resulting in hypothetical net income of USD 131,000.
The balance sheet contains USD 90,000 of cash, USD 420,000 of accounts receivable, USD 390,000 of inventory, USD 700,000 of net property and equipment, and USD 100,000 of other assets. Total assets are therefore USD 1,700,000.
Liabilities consist of USD 310,000 of accounts payable, USD 90,000 of accrued liabilities, USD 100,000 of current debt, and USD 400,000 of long-term debt. Members’ equity is USD 800,000, so liabilities and equity also total USD 1,700,000.
Accounts receivable deserves special attention because recorded revenue doesn’t automatically become available cash. Reviewing days sales outstanding and collection speed can help determine whether the USD 420,000 receivable balance is turning into cash on time.
Calculate repayment capacity, leverage, and liquidity
1. Repayment capacity
First calculate the annual payment on the proposed loan. Using a five-year amortizing loan with annual payments:
Annual payment = principal × [rate × (1 + rate)term] ÷ [(1 + rate)term − 1]
Annual payment = USD 300,000 × [0.08 × 1.085] ÷ [1.085 − 1] = approximately USD 75,137.
Total pro forma annual debt service is existing debt service of USD 110,000 plus USD 75,137 for the proposed loan, or USD 185,137. “Pro forma” means adjusted to show the expected position after the proposed transaction.
For this exercise, cash available for debt service equals EBITDA minus cash taxes and maintenance capital expenditures. Assume cash taxes of USD 35,000 and recurring maintenance spending of USD 45,000:
Cash available for debt service = USD 300,000 − USD 35,000 − USD 45,000 = USD 220,000.
Debt service coverage ratio (DSCR) = USD 220,000 ÷ USD 185,137 = 1.19 times.
A 1.19 times DSCR means the company generates about USD 1.19 under this definition for every USD 1.00 of scheduled debt payments. The positive cushion is relatively narrow: a reduction of roughly USD 34,863 in annual cash available for debt service would eliminate it. Banks may define DSCR differently, so an analyst must use the lender’s policy rather than assume this formula is universal.
2. Pro forma leverage
After the loan closes, total debt would rise from USD 500,000 to USD 800,000. Debt-to-EBITDA is therefore:
Pro forma debt-to-EBITDA = USD 800,000 ÷ USD 300,000 = 2.67 times.
This ratio shows how debt compares with annual operating earnings before interest, taxes, depreciation, and amortization. It doesn’t mean the borrower could repay all debt in 2.67 years because EBITDA isn’t cash flow and excludes taxes, capital spending, working-capital changes, and interest. For more context, see this explanation of how leverage ratios measure financial risk.
3. Short-term liquidity
Current assets are cash, receivables, and inventory: USD 90,000 + USD 420,000 + USD 390,000 = USD 900,000. Current liabilities are accounts payable, accrued liabilities, and current debt: USD 310,000 + USD 90,000 + USD 100,000 = USD 500,000.
Current ratio = USD 900,000 ÷ USD 500,000 = 1.80 times.
The quick ratio excludes inventory because inventory may take longer to sell or may produce less cash than its recorded value:
Quick ratio = (USD 90,000 + USD 420,000) ÷ USD 500,000 = 1.02 times.
The difference between the two ratios matters. Harbor appears comfortable when inventory is included, but its immediately available assets barely exceed current liabilities. Slow collections, obsolete inventory, or supplier pressure could create a cash shortfall even while the current ratio looks adequate.
Your credit review assignment
Before reading the proposed memo, prepare a one-page recommendation. This is the type of practical work sample that can demonstrate analytical judgment alongside broader finance job skills such as communication and spreadsheet accuracy.
- State whether you recommend approval, decline, or conditional approval.
- Show the annual loan payment, total debt service, DSCR, debt-to-EBITDA, current ratio, and quick ratio.
- Identify the two strongest repayment factors and the three most significant risks.
- List information that must be verified before a final decision.
- Propose conditions that directly address the identified risks rather than adding generic requirements.
Run one simple downside case as well. If EBITDA fell by 15% while cash taxes and maintenance capital spending remained unchanged, EBITDA would be USD 255,000 and cash available for debt service would fall to USD 175,000. Downside DSCR would equal USD 175,000 ÷ USD 185,137, or approximately 0.95 times. Under those assumptions, operations wouldn’t fully cover scheduled payments.
Corrected credit memo and recommendation
Borrower and request: Harbor Office Supply LLC requests a hypothetical USD 300,000 five-year term loan for equipment and working capital. The analysis assumes an 8% fixed annual rate and annual payments of approximately USD 75,137. Pricing and payment frequency aren’t actual market terms.
Primary repayment source: Operating cash flow is the intended repayment source. Based on borrower-provided figures and the exercise’s cash-flow definition, pro forma DSCR is 1.19 times. This indicates coverage above 1.00 times but limited tolerance for weaker sales, lower margins, delayed collections, or higher capital spending. The 15% EBITDA downside scenario produces a DSCR below 1.00 times.
Leverage: Pro forma debt-to-EBITDA is 2.67 times, up from 1.67 times before the proposed borrowing. The increase is material. The analyst should determine whether the new equipment will protect margins or expand capacity, but forecast benefits shouldn’t be counted until supported by customer demand, operating assumptions, and a credible annual operating plan.
Liquidity: The current ratio is 1.80 times, while the quick ratio is 1.02 times. Liquidity depends heavily on USD 420,000 of receivables and USD 390,000 of inventory. Aging schedules are necessary to assess overdue customer balances, inventory turnover, concentrations, and potential write-downs.
Recommendation: Conditional approval may be reasonable for further underwriting, but the supplied information isn’t sufficient for final approval. Conditions should include satisfactory verification of historical financial performance, acceptable receivable and inventory quality, confirmation of existing debt terms, evidence supporting equipment cost and value, and a monthly cash-flow forecast that demonstrates adequate payment capacity under a downside scenario.
This recommendation is deliberately conditional. A strong credit memo doesn’t hide uncertainty behind precise ratios. It explains which figures are verified, which are assumptions, and what could cause repayment performance to differ from the base case.
Missing information that could change the decision
- Financial history: At least several comparable periods are needed to evaluate revenue, margins, EBITDA, and cash-flow trends rather than relying on one year.
- Interim results: Recent income statements and balance sheets could reveal deterioration that annual statements don’t show.
- Receivable aging: The analyst needs overdue balances, customer concentrations, disputes, and bad-debt history.
- Inventory detail: Product age, turnover, valuation method, and obsolescence risk affect liquidity and collateral value.
- Existing loan documents: Payment schedules, interest rates, collateral liens, covenants, and maturity dates must be confirmed.
- Tax returns and bank statements: These can help reconcile reported earnings with taxes and actual cash movement, subject to the lender’s procedures and jurisdiction.
- Management forecast: Sales assumptions, gross margins, payroll, capital expenditures, and working-capital needs should be documented.
- Collateral and guarantees: Equipment appraisals, lien searches, insurance, ownership, and any guarantee requirements remain unknown.
Without these items, the ratios provide a useful screening view rather than a complete credit decision. Industry cyclicality, supplier dependence, management experience, legal claims, and customer concentration could also affect risk even though they don’t appear directly in the calculations.
Frequently asked questions
What is the most important ratio in a business loan case study?
Debt service coverage is often central because it connects available cash with required payments. It shouldn’t be used alone, since leverage, liquidity, collateral, earnings quality, and management risk can change the conclusion.
Is a DSCR above 1.00 enough to approve a loan?
Not necessarily. A ratio just above 1.00 provides little room for weaker performance, and lenders use different minimums and definitions based on their policies, the borrower, and the loan structure.
Why use EBITDA if it isn’t cash flow?
EBITDA provides a common starting point for comparing operating performance. Analysts then adjust it for items such as cash taxes, capital spending, owner distributions, and working-capital requirements to estimate repayment capacity.
Should the analyst approve or decline this hypothetical loan?
The available figures support continued underwriting and possible conditional approval, not an unconditional decision. The narrow base-case cushion and failure of the downside scenario make verification and risk controls essential.